When This Market Crashes, it Could be Bigger Than Subprime

When This Market Crashes, it Could be Bigger Than Subprime

For six years we’ve told you to ignore the ‘fake crises’.

We’ve said that the mainstream had created storms in teacups.

We told you to stay in shares.

We even told you that the Aussie market was on the way to 7,000 points.

Well, now it looks like it’s time to change our tune.

Because after getting every crash prediction wrong for the last six years, the mainstream could be about to miss the big one — again…

When we say the mainstream could ‘miss’ the next crash, we don’t mean they don’t know about it.

Rather, they’re so busy looking at the big news stories, they aren’t paying enough attention to the genuine threats.

Take this story from Bloomberg:

The worst commodities slump in 13 years is wreaking havoc for investors seeking to profit from companies in distress.

Distressed bonds have lost 8.2 percent this month as oil and coal prices slid, bringing this year’s loss to 12.2 percent, according to a Bank of America Merrill Lynch index that tracks the debt. The securities are on pace to lose more than 20 percent for the second straight year, the worst performance since 2008. SandRidge Energy Inc. bonds have lost almost 30 percent since June, while notes of miner Cliffs Natural Resources Inc. are down more than 27 percent.

It gets worse. The article goes on:

More than $7 billion of the distressed-debt market has been wiped out this month amid a renewal of a slide in commodities. The performance is a disappointment to investors who purchased about $40 billion of junk-rated bonds from energy companies this year, thinking that the worst of the slump was over.

And if that’s bad enough, there’s more…

Bigger than subprime

Just to put things into perspective, Greece’s total government debt stands at US$388 billion. It’s a big number.

However, it’s worth noting that the total ‘junk’ bond market is US$2 trillion. That’s more than five times the size of Greece’s national debt.

A company’s bonds get a ‘junk’ rating if the market and ratings agencies believe the company has a high chance of defaulting on payments.

What makes things worse is that, according to Forbes magazine, US$1.6 trillion (80% of the total amount) of these junk bonds could default between 2016 and 2020.

And if you consider that the average default rate on junk bonds since 2002 has only been 1.5%, it will be a big deal. That’s especially so for leveraged investors who thought junk bonds were ‘safe’.

To put this in further context, in 2007, the total size of the subprime mortgage market was US$1.3 trillion.

Right now, that makes the junk bond market 54% bigger.

And unlike when a sovereign state gets into trouble, junk bond issuers won’t get a bailout from a central bank or the IMF.

The interesting thing is just how much the junk bonds have fallen over the past year. You can see this on the chart below of the SPDR Barclays Capital High Yield Bond ETF [NYSEARCA:JNK]:

Source: Google Finance

This junk bond ETF is down 8% since this time last year.

And while it doesn’t mean a crash is heading our way now, it’s another warning sign to watch carefully.

Watch this market closely

The point we’re making here is that it may not be a big and spectacular event that causes the next stock market crash.

Think back to 2008. From the distance of seven years on it may have seemed spectacular, but at the time, the crash was quite ordinary.

It took a long time to play out. Remember that stocks peaked in late 2007. But they didn’t collapse until September and October of 2008…nearly a year later.

All through that year stocks ground lower, except for short rallies that gave the false hope of a recovery.

Even before the final crash, the Dow Jones Industrial Average had fallen 16%.

In other words, the start of the last financial crisis wasn’t a loud and brash catastrophe. It started quietly. That’s why so few people saw it coming.

It was only as the debt defaults began to pile up (not in anticipation of them) and the complex financial structures unravelled, that the markets begin to plunge.

That’s what investors need to look out for this time.

Ignore the mainstream’s focus on the big ‘fake crises’ like Greece, China, and the rest of it.

If you really want to know where the next crisis will start, look for the smaller but more important clues that the market sends you each day.

For now, one of those clues is in junk bonds. Pay close attention.



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Kris Sayce

Kris is never one to pull punches when discussing market developments and economic events that can affect your wealth. He’ll take anyone to task — banks, governments, big business — if he thinks they’re trying to pull a fast one with your money. Kris is also the editor of Microcap Trader — where he reveals the best opportunities he’s discovered in the markets. If you’d like to more about Kris’ financial world view and investing philosophy then join him on Google+. It's where he shares investment insight, commentary and ideas that he can't always fit into his regular Money Morning essays.

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